Inuvo, Inc.
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good day, everyone, and welcome to today's Inuvo Third Quarter 2017 Earnings Conference. Just a reminder that today's call is being recorded. And at this time, I'd like to turn the conference over to Valter Pinto from KCSA. Please go ahead, sir.

[Valter Pinto:]

Thank you, operator, and good afternoon. I'd like to thank everyone for joining us today for the Inuvo Third Quarter 2017 Shareholders' Update Conference Call. Today, Mr. Richard Howe, Chief Executive Officer; and Mr. Wally Ruiz, Chief Financial Officer, will be your presenters on the call. Before we begin, I'm going to review the company's safe harbor statement. The statements in this conference call that are not descriptions of historical facts are forward-looking statements relating to future events, and as such, all forward-looking statements are made pursuant to the Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties and actual results may differ materially. When used in this call, the words anticipate could, enable, estimate, intent, expect, belief, potential, will, should, project and similar expressions as they relate to Inuvo are, as such, a forward-looking statement. Investors are cautioned that all forward-looking statements involve risks and uncertainties, which may cause actual results to differ from those anticipated by Inuvo at this time. In addition, other risks are more fully described in Inuvo's public filings with the U.S. Securities and Exchange Commission, which can be reviewed at sec.gov. With that, I'd like to turn the call over to Mr. Richard Howe, CEO of Inuvo. Rich, the floor is yours.

[Richard Howe:]

Thank you, Valter, and thanks, everyone, for joining us today. We had a great quarter with $20.3 million of revenue, a 16% year-over-year growth rate and positive adjusted EBITDA of $253,000. We are expecting a similar year-over-year growth rate in the fourth quarter. A difficult quarter to predict because of the seasonal volatility associated with our demand partners. With a strong economy, which we have, we could see stronger holiday demand than we are currently forecasting. This Q3 to Q4 volatility has resulted in quarter-over-quarter growth rate within the 10% to 20% range historically. The current forecast has us roughly at 13%. Implication here is that our current expectation is that fourth quarter revenue will be roughly $23 million and full year revenue will be approximately $79 million. Improving margins was a component of the plan associated with the February acquisition. Since we hadn't yet operated the new business when we first shared our expectations for the year, we did so assuming we'd -- for the most part, Inuvo's status quo into 2017, and supplement that with an expectation for the acquired business. In the first month of operating the new business line, we had anticipated approximately $1.25 million of monthly revenue at about 30% gross margin. We were surprised when it only delivered $828,000 of revenue, but very pleased that the margins were in line with our expectations. So the new business revenue started off slow, but the margins were in line with expectations. We rationalized that synergies and focus would ultimately allow us to get the growth engine back on track throughout 2017. Thus, we made a conscious decision to scale back some lower margin parts of the core business, making the call to focus attention and resources at a business line that could scale and deliver more operating cash and was aligned well with our other advertising technology assets. Between February and September, this acquired business line has now grown 100%. It delivered just shy of $1.7 million in revenue in September, the single largest revenue month in the history of that business line. Coincidently, Q3 was also the highest revenue quarter in the history of the business line and we are forecasting to break that record in Q4. [Technical Difficulty] this business line now has an annualized run rate well above the $15 million we disclosed as our original expectation. The integration of this business and the focus on growth with margin are strategies that have been executed exceptionally well. And while it has come at the expense of growth in the core business, it has more than made up for that trade by delivering more margin, while still positioning for what we expect will be a double-digit growth year in 2017, and that will set us up potentially even stronger year in 2018. Now while on a gross margin basis, it might appear that we have sacrificed margin dollars this year. Company gross margins declined roughly 6 percentage points quarter-over-quarter. The actual margin dollars impact isn't quite -- is quite, in fact, the opposite. When we adjust gross margin for marketing expenses, the effective margin of the overall business has improved year-over-year in Q3 by a very healthy 24%, the outcome we had planned for when we executed on this strategy. I'll be speaking more about the technology of this business line and its importance to our overall company strategy shortly. We also continued our growth in mobile within the quarter. As of the end of September, Inuvo's revenue from mobile was at an all-time high of 66% of overall revenue. As the mobile marketplace for ads continues its growth, we are starting to see a rise in the money we receive for each thousand ads we deliver within mobile in various high-demand verticals. With the growing market for mobile ads, this is a good sign that we are positioned well for the future. We added new demand advertisers and supply publishers in the quarter and we are growing our sales teams in both areas, having already made a few new hires in Q3. We expect to continue hiring salespeople in Q4 as we gear up for the increased demand we anticipate occurring in 2018. Before I turn the call over to Wally, I'd like to talk briefly about a key differentiator that Inuvo possesses. It's not something we have explicitly highlighted on these calls, but it is absolutely a cornerstone to our growth and our strategy. The technology sector is aloft right now, with companies suggesting they possess some form of machine learning and/or artificial intelligence. Our review of our marketplace suggests that in most cases, other than the very largest competitors, the suggestions are more aspirational than they are in market. This is not the case for Inuvo. We do, in fact, have an incredible set of AI-based technologies, and I wanted to highlight them here today so you can understand the value of this business we've built and the applicability of these technologies to our future success. In our business, what most companies are trying to do is put themselves in a position where, through technology, they can sell an advertiser on their ability to build a highly targeted audience for their product and/or service. Being able to do this effectively means you need to have developed a source of information that gives you some insight about the consumers' intent, both current and past. You then supplement that information with demographics. This has always been the cornerstone of direct-to-consumer advertising. In the past, we would have called this source of information a prospecting database. Several online companies have been built and sold at attractive multiples to buyers who wanted exclusive access to this kind of data for use online. Now, unlike many of our competitors, Inuvo has in fact developed, both a proprietary knowledge database and the means to serve ads against a virtually limitless set of consumer characteristics from that database, online and across device types. Further, and this is an important distinction, we can do it both for business-to-business clients and business-to-consumer clients. For example, at a top-5 technology company client, we find enterprise buyers of cloud services. We grew that client over 40% quarter-over-quarter. For a top-5 auto manufacturer, we find consumers didn't test drive. We grew that client over 20% quarter-over-quarter. We can do this kind of targeting because the machine learning technology we exclusively own has allowed us to develop and now continuously update, a rich set of consumer intent information that can subsequently be mined for the serving of ads online. We call this capability the IntentKey. Determining an individual's intent online is an exceptionally difficult problem to solve. Imagine you are reading a website that happens to have themes related to bass guitars and jazz music. How do you know whether this website and the consumer on it were attracted to this content because they are interested in playing a bass guitar, or rather interested in the bass sound as the percussion within jazz music, 2 very different concepts. Even harder to figure out, how would you know that it had absolutely nothing to do with either of those concepts, because the key intent wasn’t bass, as in guitar or music, it was bass, as in bass fishing, because the content itself is about enjoying music while on a bass fishing experience. Humans can figure these things out because we can instantly scan a page and immediately process the words on that page to determine the actual intent. We can quickly, for this example, see that this content is actually about bass fishing experience, where bass music and a bass guitar were a part of the writers' encounter. We can do this because our brain has developed its own algorithms to help it understand the co-occurrence of things. In this example, seeing bass and guitar immediately tells our brains that this is about fishing, not guitar. And bass isn't bass, it's bass. So how did our brain learn this trick? The answer, through lots and lots and lots of example content, books, websites, television, teaching, others. We learned it. Now this is exactly how Inuvo has developed and continues to update its proprietary IntentKey. The IntentKey is the brain in this analogy. We use the Internet as our source of knowledge. The IntentKey was first built by crawling over 4 billion web pages and analyzing over 1 trillion co-occurrences of important words and concepts. This is a machine learning how to understand that when you see the word bass and guitar and fishing millions of times, the probability is more likely that it's about bass fishing, not bass guitar. Today, we have our IntentKey brain and it works shockingly well. We can throw any web page at this brain and get back and store exactly what the intent of the consumer is who is visiting that page. Through other AI techniques we've developed, we can also assign various demographic information to each record. We know, for example, that if the intent of a page is golf, then the consumer visiting that page is also likely a male, probably over 55, probably college educated with income over $100,000 a year. Every user encounter on every web page is stored for future use and learning, and ultimately, so we can align our advertisers with the exact audience they are trying to target. Beyond these capabilities, a by-product benefit for advertisers of this technology protect the brand. Brand safety has become an important differentiator online as advertisers struggle to control the ultimate location where their ads are shown. Because the IntentKey knows exactly what the intent of a page is, it can, for example, easily differentiate between a page of content written for adults and adult-oriented content. The technology is powerful. It works and it has scale. We currently have more than 500 million user records in our knowledge database and we update that information 150 million times per day across devices. This represents 90% of the entirety of online users across both the United States and Canada. We've yet to scratch the surface on all the related uses for this capability within our markets. Moving back now to the business of Q3, we experienced a dramatic rise in the number of pages where we had the opportunity to make some money, growing from $5 billion in Q2 to [Technical Difficulty] billion in Q3, giving us roughly a $3 RPM for this quarter. We expect an even larger number of page views in Q4. As we have explained in the past, a quarter-over-quarter decline in RPMs does not necessarily mean our margins are going down. Generally, we can make as much margin on $3 as we can on $5, it just takes more of $3 transactions to drive an equivalent amount of revenue. The increased page views are a good indication of market penetration. We also continued to reduce customer concentration risk. Revenue from our 2 largest media partners as a percentage of overall revenue declined by 28% year-over-year. With that, I'd now like to turn the call over to Wally for a more detailed commentary on our financial performance.

[Wallace Ruiz:]

Thank you, Rich. Good afternoon, everyone. Inuvo reported revenue of $20.3 million for the quarter that ended September 30, 2017, a 16.2% increase from the $17.5 million reported in the same quarter last year. For the first 9 months of 2017, net revenue was $55.8 million or 7.6% ahead of last year. EBITDA adjusted for stock-based compensation expense, a non-GAAP financial measure, was $253,000 in the third quarter of 2017, compared to $420,000 in the same quarter last year. On a GAAP basis, Inuvo reported a net loss from continuing operations of $986,000, or $0.03 net loss per share in the quarter ended September 30, 2017, compared to the $435,000 net loss or $0.02 net loss per share in the prior year. Noncash expenses were $1.1 million or $0.04 per share in the third quarter this year. All Inuvo business lines increased year-over-year in the third quarter other than the Digital Publishing business, which, as Rich mentioned, is a business line where we have reduced revenue in the lower margin properties in lieu of scale and margin elsewhere. We believe longer-term profitability and better shareholder value will accrue from this rebalancing. The Publishing business will remain an important component of Inuvo, providing focused supply to advertisers and a laboratory to test and optimize ad-tech innovation. However, most of the Digital Publishing business costs are in the operating expense section of the income statement as opposed to in cost of revenue. The implication of this focused [Technical Difficulty] margins though better operating results. Our February acquisition and the rebalancing of revenue has reduced the company's concentration risk, where our 2 largest media partners represented nearly 99% of our revenue in the third quarter of last year, it is now down to 71% with other direct and indirect relationships having made up the difference. The integration of the acquired business is virtually complete having already merged the teams, offices and IT resources. Overall, we incurred approximately $1 million of additional operating costs in 2017 associated with the acquisition and integration of NetSeer. As anticipated and suggested in February, the acquisition becomes accretive in the fourth quarter. Operating expenses comprised of marketing costs, compensation and selling and general administrative expense. Operating expense was $11.6 million in the third quarter of 2017, compared to $12.8 million in the same quarter last year. For the first 9 months of 2017, operating expenses were $34.5 million, down nearly 12% compared to last year, entirely due to lower marketing costs. Marketing costs are the primary costs associated with creating an audience for our Digital Publishing operation. Marketing costs were $7.2 million in the third quarter of 2017, a $2.8 million decrease from the same quarter last year. As previously mentioned, the lower spend is management's decision to curtail investment in lower margin properties and redirect resources and focus towards scalable, higher-margin business lines. Compensation expense increased by $713,000 to $2.4 million in the third quarter of 2017, compared to the same quarter in the prior year. The higher expense in the current quarter is primarily due to higher payroll costs. At September 30, 2017, we had 90 full and part-time employees. A year earlier, we had 70 full and part-time employees. The increase in headcount is primarily a function of the February 2017 acquisition. We expect compensation costs to increase due to hiring sales and customer support personnel and developers. SG&A, selling, general and administrative expense, was $2 million in the third quarter 2017, compared to $1.2 million in the same quarter in the prior year. The higher expense this year is primarily due to the higher costs associated with operating the newly acquired business, which included higher IT costs by $374,000 and higher depreciation and amortization expense by $248,000. In coming quarters, we expect SG&A expense to decrease as the full impact of cost synergies from the acquisition are realized. Net interest expense was $97,000 in the third quarter of 2017, compared to $26,000 in the third quarter of last year, due to an outstanding balance on our revolver this year and a 25 basis point higher rate. We expect higher interest expense for the remainder of the year. The interest rate in the third quarter was 5%. Our balance sheet at September 30, 2017, had cash and cash equivalents of $2.9 million and a $5 million outstanding balance on our bank revolving credit line. The revolver has a total commitment of $10 million with availability dependent upon our accounts receivable. At September 30, 2017, we had additional credit availability of this line of $3.6 million. During the third quarter, we leased approximately $516,000 of IT equipment and software from Dell. Equipment was a necessary component of the cost synergies associated with the February acquisition and the additional lease costs associated with that equipment was more than offset by the reduction in overall IT costs. During the third quarter, we filed a shelf registration form, S3, to replace the prior expired filing. The company has maintained the shelf filing for many years and has no current plan to raise equity capital. Also during the third quarter, the company purchased its own stock in the open market. In total, we purchased 45,900 shares at an average price of $0.97. With that, I'd like to turn the call back to Rich.

[Richard Howe:]

Thanks, Wally. Once we closed the acquisition in February, we modified our company strategy to accommodate accelerated growth in margins in the new business. This strategy included reducing revenue in lower margin areas of the company to position the longer-term outlook for improved growth in margin overall. We're very pleased with our performance to-date in 2017, and particularly pleased with the post-acquisition performance improvements that are now delivering both scalability and improved margins leading into 2018. We see tremendous opportunity for our machine learning technology, the IntentKey, and have already seen improvements in our sales and account management organizations since we hired a leader for that group in June. If we deliver as expected in Q4, we will have achieved the 17% compounded annual growth rate since we first provided guidance in 2014 when revenue was $49.6 million. With that, I'd like to turn the call over to the operator for questions.

[Operator:]

[Operator Instructions]. And we'll go first to Eric Martinuzzi at Lake Street Capital Markets.

[Eric Martinuzzi:]

I know you're not in a position to comment quite just yet on 2018, but if you do what you're hoping to do here in Q4, we'll have roughly 3 quarters of year-on-year growth in that mid to high teens neighborhood. And I was just wondering, is that -- you've made some investments in the business. You've digested the acquisition. Is your hope, not your guidance, but it is your hope that you could accelerate that potentially in 2018?

[Richard Howe:]

Eric, yes, the answer is clearly yes. And the -- at least the indication that we're getting right now after only having run the business for this short period and for other good things that are going on in the company give us a lot of confidence actually that 2018 could be a really nice year for us.

[Eric Martinuzzi:]

Okay. And then bringing it back to something a little bit closer here in Q4. You gave guidance for Q4 of $23 million. Maybe I missed it, but I don't recall you commenting on the adjusted EBITDA expectation. You're obviously investing in people and in support and in products, is your expectation that Q4 will be a positive adjusted EBITDA?

[Richard Howe:]

Yes. I'll answer for you, sorry, Wally. We certainly expect the adjusted EBITDA in Q4 to be a positive and to be better than Q3.

[Eric Martinuzzi:]

Okay, that's helpful. And then just for -- earlier in the quarter, it was -- towards the end of September, you had a press release that talked about working closely with Acxiom, they have a product called LiveRamp. And I was just curious to know, obviously, they are a -- they've got a huge footprint, could be a terrific partner for you. Is there any way you can -- well first of all, I'll make it a 2-part question. What exactly is the technology integration between your IntentKey and LiveRamp? And then secondly, how soon and how big could it contribute to revenue for Inuvo?

[Richard Howe:]

Yes, sure. So I'm sure, I know you know, Eric, but maybe for others, there's a lot of Acxiom DNA here at Inuvo. Many of us -- a number of us were Executives at Acxiom, but we have relationships there. Beyond that, we decided to partner, if you will, with LiveRamp in large part because we felt that they had the best technology for matching machines across device types, i.e., how can I tell, whether or not, this is the same individual across the desktop, a mobile device, either a tablet or a phone. And while we had these technology and ability to do that ourselves, we felt we'd be better served by using the exceptional technology that they have by partnering with them to do so. That was the technological reasons for doing it. How soon -- we're in the process of testing with them right now. So we're doing it on a small scale within the business and I think that's going well. And I don't think it will have a material contribution to revenue this year, but if all things play out the way we hope they will, it will contribute positively next year. And again, contribute positively because we will have a better idea of an individual across devices.

[Operator:]

We'll go next to William Gibson at Roth Capital Partners.

[William Gibson:]

You cut back on your marketing costs, but what's the outlook. I am going to push out to next year for 2018. Does that stay flat? Or could it decline a little more?

[Richard Howe:]

Well, that's a tough question to answer. So -- because we haven't even started our full-fledge planning. I should say, we have actually started 2018 planning, but we haven't completed it yet. I would say, exactly what we said on the call here, Bill, and that is, we've got a part of the business that we now feel has both growth scalability and improved margins. And so we are actually dedicating more of our attention and resources and even sales activity to the scalability of that business. Now it does not mean -- and I want to be clear with this, that we're abandoning our Properties business, because that's not the case, not at all. We still believe that the core part of the Properties business is a valuable asset that we have and a huge differentiator for reasons we've cited on prior calls. But I would say, we're going to manage that part of the business for stability more and margin more than we are for growth, maybe one way to look at it.

[Wallace Ruiz:]

Which is kind of what you see now, Bill. I think marketing costs have been relatively flat at this point for 2017.

[William Gibson:]

Okay. And so what are the limits on the growth rate here? Is it a strictly a people thing? Or there are some technology hurdles? You talked about single or double-digit growth, but that's a wide number from 10% to 90%.

[Richard Howe:]

Yes. The good news is, technologically, we have the majority of the capabilities that we believe we need to be able to scale the business. I say majority as opposed to everything you need because it's never that way. You're always tinkering with something that could drive an incremental amount of revenue. Sales, so that's why we're gearing up on the sales side of the business. Direct relationships with more media partners, more demand will help fuel the engine and more publishers. The way to where we can actually show at. So we're focusing on our attention on that. The in-between is all of the technology that we've developed that works fine now so.

[William Gibson:]

Good. And then lastly, are we -- is the data center consolidation behind us?

[Richard Howe:]

Almost. I think I said on the last call, we were a month away from it, and I believe, Wally, right, that we should be completely finished with this some time mid this month. But with that said, we have already started benefiting from cost reductions. So the cost reductions actually have been occurring incrementally. We just have not entirely realized the total cost savings [indiscernible] a couple of things that were hanging chads out there that we're trying to get fixed.

[Wallace Ruiz:]

And that's why you are to see our overhead costs continue to go down in coming quarters.

[Operator:]

[Operator Instructions]. And we'll go next to Lisa Thompson at Zacks Investment Research.

[Lisa Thompson:]

So let's talk a little bit about where are you now as far as your revenue level that you need to be cash -- to break even profitably, given what you think is going to happen to overhead? And what you think is going to margin? Do you have a revenue range where you get to profitability?

[Wallace Ruiz:]

A GAAP breakeven net income could be around $45 million.

[Lisa Thompson:]

Okay. And do you have a feel for if there's going to be seasonality in your business? Is Q1 going to be down? Or are things different now?

[Richard Howe:]

No, it's always been that way, Lisa. As you know from -- having been on our calls. So yes, we typically have seasonality downward in the first quarter and then seasonality upwards in second, third and fourth with the biggest unknown in the second quarter of the year. And it's really just the difference between how long the hangover from Q1 happens and when the kick-in for Q3 happens. Sometimes it's a little earlier, sometimes a little later, which is why Q2 is sometimes can be a dull quarter, let's just say. Then other times, it can take off when we have Q2, Q3, Q4 all going up or.

[Lisa Thompson:]

Okay. And since -- I've noticed that the margins after marketing costs for the last 2 quarters have been pretty much the same. Are you running the business now on that margin number? Or how is that going to go forward?

[Richard Howe:]

We do look at that number internally that way. In fact, so that's why I made a point of it on the call to say that when you adjust for that number at the gross margin level, you'll actually see that year-over-year, at least in Q3, and I think the same is true by the way in Q2, when you look year-over-year that there was some very, very nice margin improvement somewhere on the order of 24% in Q3, and I think it was a little less in Q2. But that was mostly because we've seen this accelerated scale and margin enhancement from the NetSeer acquisition that has been incrementally adding, right? So Q3 is the first, I don't know -- it is the biggest quarter we've had with the business.

[Lisa Thompson:]

So since they are ramping, does that mean those -- that margin goes up? Or are you managing it to spend as much as marketing to keep it at the 17% level?

[Richard Howe:]

So it is not a spend as much as it is in that business as it is in other parts of our business. But the answer to your question is yes, we're managing that thing to about a 30% gross margin.

[Wallace Ruiz:]

So yes. So as the volume increases in that higher-margin business, so the mix is going to change as we go forward. So yes, there should be some improvement there. So you've seen it run about 17% this year, right? Up through the first 3 quarters, but as that continues to scale up, that higher-margin business, you should see improvement there.

[Lisa Thompson:]

Okay, so it's not like you're just going to take the extra money and throw it in marketing.

[Richard Howe:]

No, no, no. And that business, the resource component of that business does not scale in proportion to the business itself. We have to add bodies obviously when the company gets larger, but it's not in proportion to revenue. So the net margin on that business actually as it grows starts to generate a lot of cash.

[Lisa Thompson:]

Okay, great. And let me just ask you one other thing. I saw another company say something about how Apple changed policy on cookies or something or other and that affected them. What is that about? Do you know?

[Richard Howe:]

Well, I don't know if I want to comment on what Apple does or doesn't do. What I can say is, we're not having any material impact from any changes like that.

[Lisa Thompson:]

So it doesn't affect you either way, positively or negative?

[Richard Howe:]

It hasn't affected us materially to this point, nor are we sitting around here worried about it.

[Wallace Ruiz:]

I think you're talking about the Criteo, it affected Criteo.

[Lisa Thompson:]

Yes. But I didn't really figure out what their problem was.

[Wallace Ruiz:]

It really has not -- we haven't seen any effect on our business at all.

[Lisa Thompson:]

So could that actually be a positive for you with your intent engine? Or no?

[Richard Howe:]

Could be, I don't know. We don't think about it that way, Lisa. And we know we have some really interesting and unique technology and we you think of it more that way as opposed to some change that's going on in the marketplace and whether or not we can take advantage of that change. We do think that way sometimes, but not in this instance

[Operator:]

[Operator Instructions] And gentlemen, it looks like we have no further respondents in the queue at this time. I'll turn the program back over to you for any additional or concluding remarks.

[Richard Howe:]

Thank you, operator. I'd like to thank everyone who joined us today on the call. We appreciate your continued interest in Inuvo, and we look forward to reporting our progress in the coming quarters.

[Operator:]

And ladies and gentlemen, once again, that does conclude today's conference. And again, I'd like to thank everyone for joining us today.